Punjab Chemicals and Crop Protection Limited's (NSE:PUNJABCHEM) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Most readers would already be aware that Punjab Chemicals and Crop Protection's (NSE:PUNJABCHEM) stock increased significantly by 26% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Punjab Chemicals and Crop Protection's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Punjab Chemicals and Crop Protection

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Punjab Chemicals and Crop Protection is:

11% = ₹108m ÷ ₹978m (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Punjab Chemicals and Crop Protection's Earnings Growth And 11% ROE

When you first look at it, Punjab Chemicals and Crop Protection's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 12%, we may spare it some thought. On the other hand, Punjab Chemicals and Crop Protection reported a moderate 10% net income growth over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Punjab Chemicals and Crop Protection's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Punjab Chemicals and Crop Protection is trading on a high P/E or a low P/E, relative to its industry.

Is Punjab Chemicals and Crop Protection Making Efficient Use Of Its Profits?

In Punjab Chemicals and Crop Protection's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 14% (or a retention ratio of 86%), which suggests that the company is investing most of its profits to grow its business.

While Punjab Chemicals and Crop Protection has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.

Summary

Overall, we feel that Punjab Chemicals and Crop Protection certainly does have some positive factors to consider. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Punjab Chemicals and Crop Protection visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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